Wednesday, 27 February 2013

Worth reading - a couple of studies suggesting that companies which rate highly on ESG factors will outperform financially and on the stock market.

1) The Value of Governance by professor Anita Anand of the U of Toronto on the website on the Canadian Coalition for Good Governance - "there is a strong consensus in the literature that corporate governance is linked positively to firm value"2) The Impact of a Corporate Culture of Sustainability on Corporate Behaviour and Performance by professors Robert G. Eccles, Ioannis Ioannou, George Serafeim of Harvard U. - "High Sustainability companies significantly outperform their counterparts over the long-term, both in terms of stock market and accounting performance. The outperformance is stronger in sectors where the customers are individual consumers instead of companies, companies compete on the basis of brands and reputations, and products significantly depend upon extracting large amounts of natural resources". In true academic cautious fashion, they stop short of claiming that the adoption of ESG policies causes the outperformance, as opposed to merely being associated with it, which is what they emphatically demonstrate. However, the study shows that the High Sustainability behaviour preceded in time the outperformance, which is highly suggestive of causality.

Unfortunately for those looking for investment leads, there is no list of the 180 companies they found to be in the High Sustainability group.

Worse, the intricate and extensive rating process to figure out which companies are high-ESG is beyond the reach of average joe investor. We cannot hope to collect the data, which comes in part directly from the companies and in part from laborious combing through company reports. Nor can we afford to buy the data from the various specialized ESG rating shops like those on page 13 of this Bloomberg slide pack or Bloomberg or Thomson Reuters. And it's not provided by discount brokers or on free stock search websites.

Our only recourse is to buy, or look at the holdings of, ESG-based ETFs like iShares Canada's XEN or the various US-based ETFs such as those in ETF db's Socially Responsible category. Since the message of ESG studies seems to be that high-ESG pays off on average over a long period of years, for small investors an ESG fund with many holdings is probably a better option. As usual the problem with these specialized ETFs is that their MERs are higher (by 0.4% or more) than plain old index funds, which will put some people off.

Worse still, as the big institutional investors round the world have become convinced that ESG pays and are making it an integral part of their investment selection process (e.g. see the Canada Pension Plan Investment Board blurb on why and how they do ESG), individual retail investors have so little enthusiasm for such ETFs that one of them - Pax World's North American NASI - is closing in mid-March! XEN itself has a puny $18 million in assets despite being in existence since 2007 and outperforming the gigantic market benchmark iShares TSX 60 XIU by almost 0.5% on average per annum after fees (1.91% vs 1.44%) over the past 5 years.